8.1 Costing

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Knowledge of costs incurred in using assets is critical to their effective management. Asset costs are used to:

• set operational budgets and targets for management control;

• monitor asset and program performance;

• evaluate capital projects; and

• set a basis to establish prices – the charges to be made to others for the use of the asset.

Costing systems
Asset costs and corporate systems

The costing of assets should take place in concert with the costing of other components of service delivery. Corporate costing systems should be designed with this in mind, and be able to capture the costs of assets on a whole-of-life basis, as well as the full costs of the service to which they contribute. This may require the ability to attribute portions of indirect and corporate overhead costs to individual assets.

Entities should apply an activity-based costing approach so that specific services and components of the services can have realistic costs ascribed to them.

Full costs and depreciation
Most physical assets–other than land– deteriorate with time and use. Depreciation recognises this as a cost, even though it may not immediately incur a cash expense. In accounting terms, the use of an asset results in a progressive loss of ‘service potential’, and has to be recorded as a cost.

The benefit obtained from the use of the asset is recognised in each accounting period by a depreciation expense. The full costing of services that use assets must include this expense, in addition to the other operational costs of asset use.

Life cycle costs
Life cycle costing is used to establish the full costs of controlling and operating an asset over its life, or for the period it is controlled by the entity.

Life cycle costs have three basic components:

• Capital costs: These include the costs associated with the initial acquisition of an asset, either by way of purchase, construction or commissioning, as well as enhancement costs.

• Ongoing or recurrent costs: These include all costs incurred in the course of holding and operating the asset (such as management, finance refurbishment and operating costs such as energy and maintenance).

• Salvage and disposal costs: These costs are reflected as offsets against asset sale value and translate to ‘residual value’.

Depreciation needs to be computed in a way that recognises the initial capital cost, the expected life, and the residual value at the end of the asset’s useful life. All costs over the whole-of-life cycle need to be considered when evaluating the full costs of an asset, since continuing operational costs can accumulate to exceed the initial capital costs in a relatively short time.

Life cycle costing provides a profile against which alternatives to owning and constructing assets can be examined. It also provides a means of monitoring actual cost performance, and can assist entities in making future decisions on asset design and acquisition.

Many of the life cycle costs incurred or to be incurred by an asset can be found in the entity's accounting system, but some items (such as projected future maintenance costs) may require separate studies, estimates or approximations. Opportunity costs should be included where relevant.

Asset costs
Several types of cost must be recognised and measured in order to determine the full cost of an asset. The use of accrual accounting allows all costs incurred to be measured, even though the associated cash transactions may not have taken place.

Three types of costs can be identified:

Direct costs: These costs can be specifically assigned, and are directly attributable to a particular asset. Examples include depreciation, utility costs, maintenance charges, statutory charges and taxes, cleaning and finance costs.

Indirect costs: These costs are attributable only to the total asset base, to a specific group of assets, or to the asset indirectly. Wherever possible, indirect costs need to be allocated to individual assets in a meaningful way.

The attribution of indirect costs requires a causal relationship between the cost and the asset. For example, the capital charge may be allocated in proportion to the value of the asset, or rental costs may be allocated according to the floor space occupied. Other indirect costs, for instance, are regional management service charges, insurance costs and other expenses associated with the management and operation of assets or asset groups.

Overhead costs: These costs are generally related to the assets but cannot be identified with a specific asset or asset portfolio (eg the corporate overhead associated with an entity). If an asset is controlled by a particular region, it may be appropriate to apportion the overhead costs of that region but not those of the head office.

Department of Treasury and Finance, Accounting and Financial Reporting Division Telephone 61 3) 9651 2187

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